New Swap Rules Bring New Risks

By: Tom Muller

In secured lending transactions, "swaps" have allowed borrowers to hedge against fluctuations in interest rates and currencies. Earlier this year, new swap rules under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) have come into effect, resulting in new and troubling provisions in lenders' form loan documentation.

Most swaps in secured financings occur through "over-the-counter" arrangements, not on a registered exchange. In a new effort to regulate "over-the counter" swaps, the new swap rules have instituted a "clearing" requirement for such transactions. As a result, all parties to swaps that are not executed on a registered exchange must qualify as "eligible contract participants" (ECPs). Generally, entities with total assets in excess of $10 million qualify as ECPs, so most large corporate borrowers are able to meet this minimum threshold. However, the regulators have made clear that the ECP status requirement applies not only to borrowers, but also to guarantors of swap obligations. Also, the new swap rules test ECP status each time a swap is entered into, not just at the time of loan closing.

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